The Big Idea
The Bahamas | Lost in translation
Siobhan Morden | October 1, 2021
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
The selloff this week in Bahamas sovereigns was extreme with weak investor sentiment and illiquid secondary trading. It all made the debt vulnerable to negative headlines. The catalyst was the statement from Prime Minister Philip Davis on debt liability management. “We intend to live up to our obligations,” he said, “and where we are unable to, we intend to renegotiate terms, so as not to be in default.” But the market apparently missed other parts of his message. The drop in price opens the door to a high conviction overweight in the name.
The scarcity of information of a small, off-index credit triggered a knee-jerk reaction with the benchmark BAHAM’32 down almost 14 points in the last week. The Bahamas’ -12.2% month-to-date performance registers as the worst next to El Salvador. This market reaction seems extreme, especially since it ignores the same interview from Davis stating a clear pledge to avoid default and honor external debt. The reaffirmation on commitment to pay should reassure bondholders. The country still has manageable rollover risk for small gross financing needs. That should add up to a high conviction overweight on what appears an excessive reaction to market communication lost in translation.
There are a couple of reasons that explain the recent underperformance. The Bahamas high debt ratios and large structural fiscal deficit clearly carry high liquidity and solvency risks. The recent Moody’s downgrade from Ba2 to Ba3 with a negative outlook implies a vote of no confidence. The debt sustainability strategy reflects mostly a passive and gradual approach. It is highly dependent on a cyclical recovery to bring its 100%-of-GDP debt ratios back to 50% in 10 years and on consistent market access to finance a structural fiscal deficit running at -7.7% of GDP for FY2021-2022. This precarious tradeoff requires a strong commitment to pay and access to external markets.
The comments from Davis were clearly intended to reassure the markets about commitment to honor debt for a country with no track record of default and to directly counter a local analyst’s claim that Bahamas would be next in the Caribbean to default. The markets are highly sensitive to any comments on debt liability and typically expect the worst if there isn’t a clear delineation between friendly debt liability and unfriendly debt restructuring. Davis also mentioned the appointment of technocrat Simon Wilson as Finance Secretary to further reassure the market about effective debt and fiscal management. The potential for investor communications under this new leadership may quickly reassure and clarify about their intentions.
The current backlash has almost morphed into a vicious circle that undermines market access as the 2032 issue’s yields of 9.9% are not far from distressed levels and are converging with the Ecuador curve. However, the $1.8 billion in FY2021-2022 gross financing still might be met from the $250 million International Monetary Fund SDR allocation as well as from multilaterals and liquid domestic markets that fund half of the Bahamas financing needs. This should provide sufficient breathing room for re-entry into Eurobond markets next year once the curve normalizes. The higher cost of funding due to higher US Treasury rates and adverse externals may not allow a complete recovery back to August levels; however, look for a full normalization that should reopen external funding markets.
It is also worth remembering that there are no bulky Eurobond amortizations until 2024. The Bahamas also has a track record on repayment of $257 million in annual coupon payments or 2% of GDP. Smaller countries typically have more flexibility on liquidity management since gross financing needs are much lower. It’s also atypical to struggle on a USD coupon payment, especially when foreign exchange reserves are trending higher with a huge increase from $2 billion in 2020 to $2.75 billion now. Local markets also offer sufficient liquidity, with surplus bank liquidity according to latest reports. The latest Moody’s downgrade is a reminder about medium-term solvency concerns on mostly a passive fiscal adjustment and high 100%-of-GDP debt ratios; however, the ‘Ba3’ rating (negative outlook) is still far from the ‘C’ rating category of imminent liquidity or solvency stress.
The recent Bahamas Eurobond weakness appears overdone with a clear divergence from Costa Rica and convergence with Ecuador all for a potential misunderstanding on “lost in translation” of debt liability management. The BAHAM’32 now trades at 9.9% at near distressed levels and with a ‘Ba3/BB-‘ much wider to other ‘B’ EM credits. The enhanced investor communication from the new financing team should improve investor sentiment and unwind most of the recent risk premium.
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